Fundamental inflation uncertainty

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 22 September 2006

Working Paper No. 309
By Charlotta Groth, Jarkko Jääskelä and Paolo Surico

We develop a method of quantifying the uncertainty surrounding the estimates of the fundamental inflation implied by the New Keynesian Phillips Curve (NKPC). The uncertainty is represented as a band around the fundamental inflation, and encompasses the sampling uncertainty of both the estimates of the structural parameters and the estimates of the VAR used to form a projection of real marginal costs. An empirical application on UK and US data confirms that fundamental
inflation tracks actual inflation reasonably well in both countries. For the United Kingdom the confidence band is sufficiently narrow, relative to the sample variance of inflation, to identify a number of periods where the predictions of the NKPC do not fully capture movements in actual inflation. In contrast, considerable uncertainty surrounds the estimates of fundamental inflation for the United States.

 

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